Facebook lessons learned

The Facebook IPO flameout carries both healthy and unhealthy lessons for the investment community. On the one hand, it provides ammunition to advisers seeking to warn aggressive clients against chasing the next hot initial public offering to hit the market. Advisers with such clients can refer to the Facebook experience to remind them that not all IPOs rise to the stratosphere as did the Google IPO — and that in fact, most don't. On the other hand, because it appears that some institutional investors received a skeptical analyst's report on the stock immediately before the IPO, and because Nasdaq's trading systems fumbled during early trading, it will increase the level of suspicion among more-conservative investors about the fairness of the stock market. It may tempt them to stay away from stocks and to increase their allocations to fixed-income investments and money market funds. Both the urge to chase the next hot IPO and the urge to abandon the stock market because it is so volatile and seems rigged in favor of institutional investors are dangerous to investors' financial health. Aggressive investors often seem to have short memories. They forget the bad investment ideas they had and remember only the good ones. They will remember that the investors who got in early on Google Inc. made extraordinary returns on their investments. They will likely soon forget that those unlucky enough to have received an allocation of the Facebook Inc. IPO, or who bought soon after trading began, quickly found their positions underwater.

AFTER THE FOG

It will be up to advisers to remind them of the Facebook fiasco when the next hot IPO comes along. They can remind the investors that there is often an opportunity to buy shares in the new company at a price near the IPO price, and sometimes below it, after the initial euphoria has calmed down. And a newly public company's prospects often are clearer after the fog of the pre-IPO hype has evaporated. Of bigger concern is the number of investors for whom the fiasco, and especially the suggestions that some large investors got special treatment, will be the last straw with regard to the stock market. Even before the Facebook IPO, individual investors pulled more than $9 billion out of equity mutual funds in May alone. They were worried about the financial crisis in Europe, and having been hit hard by the 2008-09 market meltdown, they are gun-shy. Some will return after the crisis in Europe is solved and the memory of the Facebook IPO has faded, but some won't. The decision not to return to the equity market, or to do so with a smaller than an age-appropriate allocation, will be unfortunate, especially for investors trying to save for retirement through 401(k) and other defined-contribution plans. The yields on bonds are so low as to make accumulating a decent retirement fund well nigh impossible, and they most likely will suffer losses when bond yields rise as they eventually must. Likewise, money market fund yields are too low to be a sensible long-term investment for those saving for retirement. Some plan participants may even be tempted to stop contributing to their DC plans when they see the balances declining because of market losses. The equity markets haven't been kind to investors in the past decade, and going forward, equity markets are unlikely to provide the 10%-plus compound annual returns they delivered between 1926 and 2000. However, over the long term, they still should provide a healthy premium over bonds, especially given the high bond prices. Financial advisory professionals must keep their clients from making serious asset allocation mistakes because of a jaundiced view of the equity markets.